Woodward v. Metro Bank of Dallas

• Decision Date: 03 November 1975
• Docket Number: No. 74-2897,74-2897
• Citation: 522 F.2d 84
• Parties: Fed. Sec. L. Rep. P 95,351 Billie Jean WOODWARD, Plaintiff-Appellant, v. METRO BANK OF DALLAS et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 84

522 F.2d 84

Fed. Sec. L. Rep. P 95,351

Billie Jean WOODWARD, Plaintiff-Appellant, v. METRO BANK OF DALLAS et al., Defendants-Appellees.

No. 74-2897.

United States Court of Appeals Fifth Circuit.

Nov. 3, 1975.

Frank G. Newman, Lawrence G. Newman, Dallas, Tex., for plaintiff-appellant.

Hubert D. Johnson, H. Dee Johnson, Jr., Dallas, Tex., for Metro Bank and others.

Appeal from the United States District Court for the Northern District of Texas.

Before CLARK, ^* Associate Judge, and GOLDBERG and AINSWORTH, Circuit Judges.

GOLDBERG, Circuit Judge:

This case brings before us the unfortunate predicament of one who claims she was defrauded in connection with the purchase and sale of a security and who accordingly seeks to invoke the broad, but not unbounded, protection of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1970), and its implementing Rule 10b-5, 17 C.F.R. § 240.10b-5 (1975). ¹ This is not a difficult case decisionally, but it is thicketed with explicatory thorns. We must be certain that neither all commercial banking transactions, nor accommodation loans, nor notes are beyond the pale of 10b-5's strictures. We must interpret the Act so that financial ingenuity cannot overrun the legitimate scope of its coverage. The district court, after a full trial, dismissed plaintiff's suit for want of jurisdiction, holding that a ninety-day note was exempted from the Exchange Act by section 3(a)(10), 15 U.S.C. § 78c(a) (10) (1970), ² and that an ordinary commercial loan did not constitute a "sale" under the Act. Although we agree with the result reached by the court below, we affirm on different grounds, finding that plaintiff has failed to state a claim within the ambit of the securities laws.

I. Factual Setting

The characters in this unhappy saga form a sort of Eternal Triangle. At one point is Billie Jean Woodward, the plaintiff, described as a recently divorced housewife with painfully little business acumen. E. Trine Starnes appears at the second point, once a successful businessman with a glowing future, president and controlling shareholder of Cosmetics International Corporation (CIC), and president of CIC's wholly owned subsidiary International Psycho-Cybernetics Corporation (IPC). Metro Bank of Dallas ³ and its officer Ron Turnbull complete the design. For a period of time from November 1972 to April or May 1973, Metro held the principal CIC accounts; then in April or May Metro asked CIC to change banks, because the account had proved unprofitable. Starnes also opened a personal account at Metro in November 1972. The record does not reflect when this relationship ended, aside from some testimony indicating it was after the termination of the corporation's account. Turnbull was the officer in charge of both accounts at all relevant times.

The brief liaison between Metro and CIC occurred during a period when the company was sinking into a financial position so grim that in August 1973 it declared Chapter XI bankruptcy. This tragic denouement, however, was still in the future at the time CIC opened its account at Metro, furnishing the bank with a pro forma financial statement dated September 30, 1972. The statement was adjusted to reflect $500,000 of long term debt assumed by CIC in October as if it had been received and disbursed as of September 30. ⁴ With this adjustment, the CIC balance sheet showed $401,960 cash in bank and on hand, $748,638 total current assets, and $1,564,314 total assets. Current liabilities equalled $499,825, which was $97,865 more than the cash on hand, but $248,813 less than current assets. Finally, the statement revealed a deficit retained earnings figure of $591,702. The income statement showed a positive total net income for the month of September of $40,538, but it showed a loss for the year to date of $150,715.

In November 1972, Metro loaned $45,000 to CIC. In December, it loaned an additional $47,000 to the corporation, for a total outstanding indebtedness of $92,000. ⁵ Throughout the brief history of the CIC account, the company was plagued with a fairly large number of insufficient fund (NSF) checks. ⁶ Turnbull testified that Metro did not extend overdraft privileges to CIC; rather, its practice was to contact the company whenever a check was returned and to request a deposit to cover the check. Metro received transfers to CIC's account from nearly forty other banks located around the country; according to Turnbull, the NSF occurrences brought to his attention were covered by these transfers from other banks.

We now turn our attention to the development of the Starnes-Woodward relationship. These two met in December, 1972, when Starnes approached Mrs. Woodward to see if she wanted to purchase 25,000 shares of IPC stock from CIC. Falsely reporting that CIC's financial health was glowing, Starnes told Mrs. Woodward that no CIC stock was presently available, but that another person had loaned the corporation $500,000 with the understanding that he would be repaid with stock. At that time Mrs. Woodward bought the IPC shares for $50,000. On February 15, 1973, Starnes telephoned Mrs. Woodward and invited her to fly from San Antonio, her home, to Dallas to discuss CIC's business. She did so, and at a meeting on February 21 in Dallas, Starnes asked her to co-sign a note for $150,000 to provide "working capital" for CIC. He also suggested that she back the note with some Texaco and Timken stock worth $185,000 that she owned. In return for her assistance, Starnes promised to pay her $1250 per month during the life of the note in return for "counseling" services for CIC and IPC ⁷ and, as the trial court found, as compensation for her signature. Finally, Starnes asked her to serve on the Board of Directors of CIC. Starnes at no time disclosed to Mrs. Woodward the true facts of CIC's failing finances, the frequent NSF checks, or the outstanding $92,000 of loans from Metro.

The first time this triad converged was on February 28, 1973, when after some misgivings on Mrs. Woodward's part they met in Turnbull's office at Metro to conclude the loan transaction. ⁸ Mrs. Woodward then learned that Metro had decided to require a $200,000 loan, with $50,000 of the proceeds to be invested in a non-interest bearing certificate of deposit (CD). The note had a term of ninety days and bore an interest rate of 8.5%. The loan itself was to Starnes personally; the Statement of Purpose of the Proceeds of a Stock-Secured Extension of Credit by a Bank (Regulation U form) ⁹ stated that the proceeds would be used "to furnish working capital for Cosmetics International Corporation." (See Plaintiff's Exhibit 9.) Mrs. Woodward signed two security agreements, one pledging her stock as collateral and the other pledging the $50,000 CD against "all indebtedness now owing to (the bank) or which may hereafter become owing . . . ." This cross-collateral provision is significant because at the time, Starnes had two outstanding personal loans with Metro totaling $29,500. These were subsequently renewed in April, with a $5,000 reduction in principal, and again in July. Plaintiff does not discuss Starnes' personal finances, but according to Turnbull's testimony an investigation of his payment record at other banks revealed no adverse information. Immediately after the loan was consummated, Starnes transferred the $150,000 to the CIC account. That day, $90,000 of CIC's checks were paid. ¹⁰

Mrs. Woodward received her checks for $1250 until June, when one was returned NSF. When in May the February 28 note became due for renewal, the bank asked Mrs. Woodward either to reduce the principal amount or to provide additional collateral, since the value of her Texaco and Timken shares had fallen slightly. Reluctant to encumber her assets further, she chose instead to accept from Starnes twenty-five checks payable to Metro for $1,000 each, which she could use to reduce the note. Relying on this arrangement, on May 29 she signed a renewal note. Afterwards, she discovered that the checks from Starnes were drawn on an account held by a different Dallas bank with insufficient funds. In August 1973, Turnbull informed her that CIC had filed bankruptcy proceedings. ¹¹ Since Starnes did not pay the renewed note when it became due, the bank turned to Mrs. Woodward to collect its funds. The $50,000 CD was used first to liquidate the earlier personal loans Starnes had outstanding. Applying the balance to the $200,000 note, Metro threatened to foreclose on the pledged securities unless Mrs. Woodward paid the remaining amount due.

II. Resort to the Courts

Promptly reacting to Metro's demand for payment, Mrs. Woodward filed suit in the United States District Court on August 27, 1973, alleging federal jurisdiction under section 27 of the Securities Exchange Act of 1934, 15 U.S.C. § 78aa (1970) for violations of section 10(b) of that Act, 15 U.S.C. § 78j(b) (1970) and Rule 10b-5, 17 C.F.R. § 240.10b-5 (1975). She named Metro Bank, Starnes, and Turnbull as defendants. The complaint charges Starnes with devising a scheme to defraud her; it alleges that all defendants knew material facts about CIC's financial status and the use of the loan proceeds, but failed to disclose these facts, and it seeks to hold Metro and Turnbull as aiders and abettors. The promissory notes are alleged to be securities within the meaning of the Securities Exchange Act. The relief demanded in the complaint includes an injunction against foreclosure and sale of the stock, an order requiring Metro to return the shares to Mrs. Woodward, and cancellation of the note (or in the alternative, $200,000 plus interest). ¹² Metro Bank and Turnbull answered, claiming lack of federal jurisdiction and failure to state a claim upon which relief could be granted, and specifically denying their connection to any fraud. Metro filed a state law counterclaim against Mrs. Woodward and a cross-claim against Starnes for judgment on the debt and...